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EDITOR’S COMMENT: We’ve been saying here for 4 years that ultimately the ONLY way out of the economic crisis is to use real data and skip the ideology, blame and politics. Nocera, pouring over data accumulated by intensive analysis, states that the data proves this point and more. What we need are economic policies that are based upon reality. Since housing is the leader in any recovery for dozens of reasons — from direct jobs and commerce to psychological (confidence) — the ever-increasing bubble in housing inventories flooding the market and driving down prices must be popped.
The principal driver of new defaults is the futility of paying on a loan for property that will never be worth the amount of the loan — i.e., underwater property. The foreclosure crash is causing the number of housing units waiting for a market to buy them to increase at a rate that few would have predicted because of their closely held belief that the mortgages were, in the end, valid debts. Whether true or not, the only tool available to stem the tide and fix the problem is to change the amount due from borrowers.
Last night, Beau Biden, Attorney general of Delaware who sued MERS last week, cast doubt on that assumption along with other suits by other attorney Generals, the principal regulators of banks and many lawmakers. In Biden’s words, the recording system in this country was “privatized” and with that went any possibility of a reliable method for tracing title. Biden, son of Joe Biden, VP, states that at least 25% of all foreclosures occur with the wrong party initiating the foreclosure. He predicted that without correcting the problems created by the Banks we will be “talking about the same problems in 5, 10, 15 and 20 years.”
The real facts are leading inexorably to the question of whether some, many or even all of the loans claimed to be securitized — mortgage, credit cards, student, auto and other consumer loans — were ever perfected and specifically whether the paperwork matches up with the deal and the obligations of the parties (according to law) at the time the loan transaction was consummated. If we do what is right for the country the problem is fixed. If we do what the Banks want, we stay with the problem indefinitely with no prospects for recovery.
Analysts, economists and finance experts are now arriving at the same conclusion — along with the only tool available to stop the foreclosure crash. In order to fix the economy we need to fix what ails it — principally housing. In order to fix housing, as prices continue into their death spiral, we must stop the glut of “defaults” and foreclosures. If we don’t do it now, we are condemning future generations to a world of hurt. It isn’t about ideology, it’s about survival.
It no longer matters what rationale is advanced to correct principal balances claimed as due — we just need to do it. But a key factor that Nocera and Goodman miss is that the balances claimed are not the balances due. The balances have been reduced by actual payments received by the creditors and their agents and then hidden and booked as Bank assets or Bank profits, cheating both the investors and the borrowers.
In fact, we have repeatedly seen in the distribution reports for investors, the same loan that is declared in “default” has the payments made by the servicer under separate contracts never revealed to the borrower and obscured to the investor. While foreclosure on the “default” proceeds, the creditor continues to get paid on a loan reported as “performing.” Hence the default was declared without any factual basis. And the foreclosures were processed based upon a defective assumption of delinquency and default from the servicer’s perspective — but not from the creditor’s perspective.
While complex, this is not beyond the understanding of bankruptcy and probate courts that tend to take a close look at the loan’s status as perfected lien, priority of liens etc. The payment by the servicer decreases the principal amount due from the borrower and cures or eliminates the default because the creditor has been paid. Since the creditor has been paid it can no longer claim the balance that was due before receiving the servicer’s payment. The same holds true for other payments received by the creditor or its agents on insurance, credit default swaps and other contracts without rights of subrogation.
These third party payments do not decrease the overall obligation of the borrower but they change the character of the obligation. No longer secured by the note and mortgage (if they were ever valid or perfected) these third parties have unsecured claims in the same amount as the amount of the reduction of the payments and principal alleged as due.
Just applying normal rules of accounting and law, part of the borrower’s obligation changes from secured to unsecured, with the secured portion decreased by the same amount that the unsecured portion is increased.
More importantly, the parties change from the creditor who advanced the money to fund the loan to a third party who has covered that obligation. Hence, a principal correction (or reduction, if you must call it that) with the investor-lender may not be nearly as great as the current estimates of 30%-50%.
In fact, in some cases, the investor lender may be entitled to money from the Banks received from third parties but remain hidden in an exotic accounting system, for which the auditing firms may have exposure for liability. The principal in such cases would need not be “reduced” or ‘corrected” by fiat, in such cases, it would be reduced by arithmetic. The result is the same for the homeowner — a much lower amount due reflecting true values that should have been reflected in the initial transaction but were hidden by an appraisal process that was corrupt.
This is why the OCC Review process MUST take into account an accounting for all money received and disbursed in relation to both the loan and the pool claiming ownership of the loan — because regardless of whether the loan ever legally reached the pool, the money DID reach the pool.
By sticking to the facts and applying arithmetic and simple established law, the number of people who consider themselves underwater will change from millions to perhaps a small fraction of that amount, if any. The impending new defaults would be eliminated and the foreclosures that did or are taking place can be corrected, while avoiding future foreclosures. The number of homes on the market or headed to market would vanish, this allowing free market conditions to allow prices to go wherever the market deems fit between arms length buyers and sellers.
To Fix Housing, See the Data
In Miami recently, I met up with Laurie Goodman, a senior managing director of Amherst Securities. I’d been trying to meet her ever since I’d read an article that she had written in March entitled “The Case for Principal Reductions.” But our schedules never seemed to mesh. So when I noticed that we were both going to be at a conference in Miami, I wangled a breakfast appointment. It was one of the more illuminating breakfasts I’ve had in a while.
The idea of helping struggling homeowners by writing down some principal on their mortgages — as opposed to reducing the interest or reconfiguring the terms to lower the monthly payments — is much in the air right now. Banks loathe the idea of principal reduction; they fear that people who are current on their mortgages will start defaulting just to get their principal reduced. They also don’t want the hit to their balance sheets.
But the states’ attorneys general who sued over the robo-signing scandal have made principal reduction the central plank of the settlement they are close to completing. The settlement will force the big banks to begin a sustained program of principal reduction, and will heavily penalize banks that don’t comply. From what I hear, the goal of the states is to prove to the banks that principal reduction will not cause the sky to fall — and is, ultimately, less damaging to bank profits than foreclosures.
Housing activists love principal reduction because they tend to see it as a just solution to an unjust situation — it’s a way of making the banks pay a real price for their sins during the subprime madness while allowing people to keep their homes. Conservatives, on the other hand, hate principal reduction. They believe that borrowers who made poor decisions by taking out mortgages they could never afford have to take responsibility for those decisions. If that means foreclosure, so be it.
Enter Laurie Goodman. One of the country’s foremost authorities on mortgage-backed securities, she is also one of the most data-driven people I’ve ever met; at breakfast, she was constantly pointing me to one chart or another that backed up her claims. “She’s not into politics,” says my friend, and her client, Daniel Alpert of Westwood Capital. “She is using data to tell us the truth.”
Her truth begins with a shocking calculation: of the 55 million mortgages in America, more than 10 million are reasonably likely to default. That is a staggering number — and it is, in large part, because so many homes are worth so much less than the mortgage the homeowners are holding. That is, they’re underwater.
Her second calculation is that the supply of housing is going to drastically outstrip demand for the foreseeable future; she estimates that the glut of unneeded homes could get as high as 6.2 million over the next six years. The primary reason for this, she says, is that household formation has been very low in recent years, presumably because of the grim economy. (Young adults are living with their parents instead of moving into their own homes, etc.) What’s more, nearly 20 percent of current homeowners no longer qualify for a mortgage, as lending standards have tightened.
The implication is almost too awful to contemplate. As Goodman put it in testimony she recently gave before Congress, the supply/demand imbalance means that housing prices “are likely to decline further. This may recreate the housing death spiral — as lower housing prices mean more borrowers become underwater.” Which makes them more likely to default, which lowers prices further, and on and on.
The only way to stop the death spiral is through principal reduction. The reason is simple: “The data show that principal modifications work better” than other kinds of modifications, she says. Interest rate reductions can lower monthly payments, but the home remains just as underwater as it was before the modification. And the extent to which a home is underwater is the single best indicator of whether the homeowner will default. The only way to change the imbalance between the size of the mortgage and the value of the home is to reduce principal.
Will widespread principal reduction cause homeowners to purposely default on their mortgages? Goodman has some ideas about how to reduce that likelihood, but she is also realistic: “A borrower will make a decision to default if it is in his or her best interest.”
One wishes that the country could make economic decisions that are in its best interest, decisions that use Laurie Goodman’s data-driven approach instead of being motivated by ideology. Goodman’s case for principal reduction is powerful precisely because it is not about just or unjust, or who’s to blame and who’s at fault.
It is about cold, hard economics. Three years after the bursting of the subprime bubble, principal reduction isn’t just a nice-sounding way to help homeowners. It is our only hope of finally ending the housing crisis.
Tags: Amherst Securities, bankruptcy, borrower, countrywide, Daniel Alpert, defaults, disclosure, foreclosure, foreclosure defense, foreclosure offense, foreclosures, fraud, housing prices, investor recovery, Laurie Goodman, LOAN MODIFICATION, modification, OCC REVIEW, PRINCIPAL CORRECTIONS, principal reduction, quiet title, rescission, RESPA, securitization, The Case for Principal Reductions., third party payments, TILA audit, trustee, underwater, WEISBAND
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